Canada: Federal Budget 2011: A Few Pensions And Benefits Changes Of Interest

Unlike many past federal budgets, the 2011 federal budget (Budget 2011) tabled by Finance Minister James Flaherty on March 22, 2011 (Budget Day) contains only a few tax measures of interest to the pensions and benefits community. Given the nature of the proposals, it is quite probable that they will eventually, in some form, be enacted into law regardless of the outcome of the election. The most significant proposed changes relate to Registered Retirement Savings Plans (RRSP) and Individual Pension Plans (IPP).

INDIVIDUAL PENSION PLANS

The Canada Revenue Agency (CRA) has for some time had concerns with respect to defined benefit registered pension plans established for the benefit of a single individual by a corporation that the individual controls. Particularly troublesome to CRA are situations where there is a transfer to such an IPP of the commuted value of the individual's pension entitlement under a large pension plan (e.g. the Ontario Teachers' Pension Plan) at the time of the individual's retirement. The amount transferred from the large plan to the IPP often exceeds the amount that would have been permitted under the tax rules if the transfer had instead been to an RRSP. Where the individual does not receive earnings from his/her corporation comparable to those received with the prior employer a large surplus may be created in the IPP (since the lower earnings result in lower pension benefits). CRA has taken issue with many of these types of IPPs on the basis that they do not meet the requirement that the primary purpose of the plan be to provide pension benefits in respect of service as an employee. CRA has either retroactively de-registered the plan or has refused registration in the first place. In the courts CRA has had a successful track record of having its position upheld. Despite this it is apparently the view of the Government that legislative action is appropriate. The two changes proposed by Budget 2011 will apply to plans falling within the new definition of "IPP". In general, a plan with three or fewer members will be an "IPP" if at least one member is "related'' to the employer who sponsors the plan (an individual is "related" to a corporation controlled by him/her).

Annual minimum withdrawal: Beginning in the year in which the member attains age 72, the IPP will be required to pay out to the member each year the greater of (i) the regular pension amount otherwise payable; and (ii) the minimum amount that would be required to be paid if the IPP were instead a Registered Retirement Income Fund (RRIF). Under the current tax rules there are no minimum withdrawal requirements with respect to plan surplus. Accordingly, in the situation where a large surplus has been created in the IPP as described above, this change will ensure that the surplus is paid out to the member throughout retirement rather than being retained in the IPP indefinitely. The new rule takes effect beginning in 2012. Existing IPPs will presumably need to be amended to provide for the new annual minimum withdrawal (assuming this change ultimately becomes law).

Past service contributions: More restrictive rules will apply with respect to past service benefits provided under an IPP. The cost of past service must first be paid by a transfer of RRSP assets of the member to the IPP or through a reduction of the member's accumulated RRSP contribution room before the member or the employer can make any tax-deductible past service contributions. This change will generally apply to past service contributions made to an IPP after Budget Day.

RRSPS AND RRIFS – NEW ANTI-AVOIDANCE RULES

Budget 2011 extends anti-avoidance rules currently applicable to Tax Free Savings Accounts (TFSAs) to RRSPs and RRIFs (together referred to as RRSPs). The advantage rules, the prohibited investment rules and the non-qualified investment rules will now apply, with appropriate modifications, to RRSPs. In recent years a number of tax planning arrangements involving RRSPs have been aggressively promoted to taxpayers. Such arrangements include those purporting to allow taxpayers the ability to access RRSP funds without including any amounts in income, those in which payments on account of services rendered are made to an RRSP, and those in which two or more securities are offered in tandem, allowing the streaming of certain types of income disproportionately between the annuitant directly and the annuitant's RRSP. Although the CRA has successfully attacked such schemes in the Courts, these proposals will provide the Government with additional tools to combat abusive arrangements.

Advantage Rules: Under the TFSA rules, a tax in an amount generally equal to 100% is levied on an "advantage" in relation to an TFSA. The Minister of National Revenue (the Minister) may waive all or a portion of this tax where it is just and equitable (having regard to the circumstances) and an amount equal to the advantage has been distributed from the TFSA. These rules will be adapted to apply to RRSPs. An RRSP advantage will include:

1. subject to specific exceptions, a benefit, loan or indebtedness that is conditional in any way on the existence of the RRSP;

2. an increase in value of property held in connection with the RRSP, if it is reasonable to consider that the increase is attributable (directly or indirectly) to:

(a) a transaction or series of transactions that would not have occurred in an open market, where one of the main purposes of which was to benefit from the tax exempt status of the RRSP;

(b) a payment for services provided by the RRSP annuitant or a person who does not deal at arm's length with the RRSP annuitant;

(c) a payment of investment income (dividends, interest, rent, etc.) in respect of property held outside of the RRSP of the RRSP annuitant or a person who does not deal at arm's length with the RRSP annuitant;

(d) a payment received from a swap transaction (which is a transaction that is not a contribution to or withdrawal from an RRSP); or

(e) a payment received from specified non-qualified investment income (generally second and subsequent generation income, including capital gains, earned on non-qualified investment income) which is not removed within 90 days of notice by the Minister; and,

3. income (including capital gains) derived from a "prohibited investment".

With respect to an advantage, the tax will be levied on the RRSP annuitant except in cases where the advantage is extended by the issuer of an RRSP (or carrier of a RRIF) in which case the tax will be levied on such issuer or carrier.

Prohibited Investments: The TFSA prohibited investment rules will be adopted for RRSPs. Prohibited investments involve closely-held investments, including debts of the RRSP annuitant, shares or other interests in corporations, partnerships and trusts in which the RRSP annuitant holds, or persons who does not deal at arm's length with the RRSP annuitant hold, a significant interest (generally 10% or more), or rights to acquire such debts, shares or other interests. Prohibited investments will be subject to a special tax equal to 50% of the fair market value of the investment at the time the investment is acquired by the RRSP. The tax is refundable if the investment is disposed of by the end of the year following the year the tax applied (or such later time as the Minister considers reasonable), unless the RRSP annuitant knew or ought to have known that the investment was a prohibited investment at the time of its acquisition. The Minister also has the discretion to waive all or part of the tax if just and equitable to do so.

Income from prohibited investments is considered an "advantage" and subject to the 100% tax on advantages discussed above.

Non-Qualified Investments: Currently, where an RRSP acquires a non-qualified investment, the RRSP annuitant must include the fair market value of the investment in income, and will generally be entitled to a deduction (up to the amount of the initial income inclusion) in the year of disposition. Budget 2011 proposes to tighten these rules as follows:

1. when the non-qualified investment is acquired or at the time an investment becomes a non-qualified investment (as the case may be), the RRSP annuitant will be subject to a tax in the amount of 50% of the fair market value of the investment; and

2. the RRSP annuitant will be entitled to a deduction in the year of disposition, provided the disposition occurs by the end of the year following the year in which the tax applied (or such later time as the Minister permits).

Income earned in the RRSP on a non-qualified investment will continue to be taxable in the RRSP at a rate of 1% per month.

Investments which are both non-qualified investments and prohibited investments will be subject to the prohibited investment rules only.

Application to Existing RRSP Assets: A benefit arising from a swap transaction will not be considered an advantage in relation to the RRSP if the swap transaction is completed before July 2011, or is completed before 2013 for the purpose of removing an investment from an RRSP that would, by virtue of the Budget proposals, be a prohibited investment of the RRSP or result in an advantage in relation to the RRSP. Further, the refundable tax on prohibited investments will not apply to a prohibited investment that was acquired before Budget Day, provided it is disposed of before 2013. These are the only relieving provisions in the application rules. All other RRSP proposals, if enacted, will apply to transactions occurring and investments acquired after Budget Day. A "transaction occurring" is deemed to include investment income generated after Budget Day on previously acquired investments. Therefore, all income earned on an investment after Budget Day, where such income is a benefit which constitutes an advantage, will be subject to the 100% tax levied on an advantage.

OTHER MEASURES

Minor amendments of a relieving nature are proposed for Registered Disability Savings Plans (RDSP) and Registered Education Savings Plans (RESP). The Government also announced its intent to address perceived abuses relating to Employees Profit Sharing Plans (EPSP), but will consult with stakeholders before proceeding with any amendments in this area.

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